Economic crisis exposes Germany’s ideological stalemate

Germany is the worst-performing major economy in the world, but ideological differences within the governing coalition are preventing a strong response, one way or another.

There is a saying in several European countries that points to the deep interdependence between the industrial giant and its European neighbours: “When Germany coughs, the Netherlands [Austria/Poland/the Western Balkans…] catch pneumonia”.

It explains why many European countries view the current German economic crisis with strong unease. And they have good reason to be worried.

According to new projections released by the International Monetary Fund this week, the country’s economy will grow just 0.2% this year, after having contracted by 0.3% last year. 

To the disappointment of the country’s business and industry community, the government is divided on how to tackle the problem – or even how big it is.

“As a former mayor of Hamburg, I know that the businessman’s [way of] greeting is [usually] a complaint,” Chancellor Olaf Scholz (SPD) said last month after a meeting with business associations, which strongly lamented the situation.

While Scholz is calling for calm despite the bad figures, his deputy, Economy Minister Robert Habeck (Greens), and his informal second deputy, Finance Minister Christian Lindner (FDP), are vigorously sounding the alarm bells.

But when it comes to analysing the root causes of the problem, the two already differ.

For Lindner, the problems are structural. The powerful boost the German economy received in the years before the COVID crisis, from exceptionally low interest rates, cheap Russian energy and strong demand from China, actually represented a “special economic situation”, Lindner told an event this week.

“These exceptional factors have now been pulled back like a curtain, and we can see the structural reality of our economy,” he said.

Lindner pointed to a decline in long-term growth potential to just 0.5% over the next few years, down from 1% before the pandemic and 2.5% in the 1970s – based on figures from the German Council of Economic Experts. 

For Habeck, on the other hand, it is the current economic weakness – which he blames on the ongoing war in Ukraine – that is the exception.

“The war is still weighing on the German economy”, which, coupled with high interest rates, slower global trade and lower consumer spending, explains the current – and therefore cyclical – slump, he said in February.

“In perspective, however, we see clear signs that the trend may improve again,” Habeck added.

Not surprisingly, Lindner and Habeck’s proposed responses to the crisis are also fundamentally different – or rather, diametrically opposed.

Habeck advocates more subsidies for the German industry to allow it to transition to climate neutrality without taking vast losses – something his party promised its voters.

However, while Habeck’s ministry is busy getting the go-ahead from Brussels for one multi-billion euro support programme after another, his most ambitious plans are being blocked by Lindner, who insists on not exceeding the constitutional budget deficit limit of 0.35% of GDP (adjusted for the business cycle). 

Lindner’s faith in the “debt brake” mechanism is so unwavering that he stated this week that the ceiling has greatly helped the country fight inflation and avert the risks stemming from a large-scale subsidy scheme similar to the US’s Inflation Reduction Act (IRA) – which Habeck had proposed alongside a subsidised electricity price cap for heavy industries.

The government initially tried to circumvent the debt brake by using “shadow budgets” that did not count against the deficit limit, but was stopped by a far-reaching ruling by the Constitutional Court last November.

If the government still wanted to exceed the deficit ceiling, it would have to proclaim a state of emergency, the court ruled – something Lindner opposes as it would undermine the purpose of the debt brake in the first place.

Since then, Habeck and Scholz’s Social Democrats – but not the chancellor himself – have been calling for a fundamental reform of the debt brake, which will not happen as long as Lindner is finance minister, and would require the support of the conservative opposition CDU/CSU (given the two-thirds majority needed to change the Constitution).

On the other hand, Lindner’s recipes for growth – presented at a conference on economic policy at his party headquarters this week – won’t be implemented either, as long as he governs with the Social Democrats and Greens.

Longer working hours, later retirement, lower corporate taxes, stricter conditions for unemployment benefits to ‘incentivise work’: All too bitter pills for the centre-left to swallow.

So while welfare spending continues to rise and spending limits continue to bite, cuts in investment – especially on Habeck’s industrial policy ambitions –  are looming closer on the horizon and casting heavy clouds – not least when the time comes this summer for the government to draft the 2025 budget and fill a hole of around €25-30 billion.

Given the current poor approval ratings of the coalition government and of its three individual parties, the government seems doomed to stay together until the next regular election in 2025 as going to the polls early would bring paltry results to each component.

But its ideological divisions are preventing a strong political response to the country’s economic crisis – one way or another.

Chart of the Week

Germany is on a special path.

As economist Peter Bofinger, a former member of Germany’s Council of Economic Experts, posted on X, not only is its growth rate much lower than in other large economies, but so is its government’s budget deficit – as shown by the IMF World Economic Outlook.

The assessment of the outlier differs, depending on the economic theoretical standpoint.

While Bofinger criticised that “the main function of the debt brake is to prevent the state from being able to finance profitable investments through loans”, Dorothea Siems, chief economist of conservative newspaper Die Welt praised the mechanism:

“Highly indebted countries such as France, Italy and the USA are [struggling] under the burden of debt servicing, and borrowing is becoming immensely expensive for them,” Siems wrote. “At least Germany has this problem under control – thanks to the debt brake.”

Germany’s economic growth figures, however, may tell a different story.

Economic Policy Roundup

Letta presents long-awaited report on the future of the EU single market. On Thursday (18 April), former Italian prime minister presented his long-awaited report under the title of “Much more than a market”. Euractiv has prepared summaries of the most important proposals:

• Capital markets: ESMA should supervise largest market players
• Energy: Europe’s Energy Union as a key priority
• EU enlargement: New fund to balance future EU enlargement
• Tech: Creation of EU Deep Tech Stock Exchange
• State aid: US-IRA-style funding, pan-European state aid contribution scheme

Capital Markets Union best route to rival US IRA, Michel says as Letta outlines sweeping financial sector plan. European Council president Charles Michel said on Wednesday (17 April) that Europe’s answer to the US’s multibillion green subsidy programme should be to deepen its single market for financial capital. Speaking at a press conference in Brussels alongside Letta, Michel said further integration of the Capital Markets Union (CMU) would unlock “trillions of euros” in potential investments, thereby rivalling if not surpassing the $369 billion US Inflation Reduction Act (IRA). Read more.

Draghi: EU must enact ‘radical change’ as US and China refuse to ‘play by the rules’. Europe must undergo “radical change” to remain competitive in the face of China and the United States’ refusal to “play by the rules” of international trade, the former president of the European Central Bank Mario Draghi said on Tuesday (16 April). “Others are no longer playing by the rules, and are actively pursuing policies to enhance their competitive positions,” Draghi said at a conference on European social rights in La Hulpe, Belgium. Read more.

Germans must work more to boost weak economy, employers association, Deutsche Bank say. Germans must work longer hours and retire later to increase economic growth, the heads of the employers’ federation, BDA, and Deutsche Bank said. “The concept of work-life balance has somehow been overdone,” Rainer Dulger, the head of the German employers’ federation BDA, told an event organised by the liberal FDP party on Tuesday (16 April). Christian Sewing, CEO of Germany’s biggest lender Deutsche Bank, agreed. “We have to work more, certainly differently, but also harder. We have to understand that we have to earn our prosperity before we distribute it,” he said. Read more.

Von der Leyen bows to pressure as Pieper drops SME envoy job. European Commission President Ursula von der Leyen said the position of SME Envoy would be filled after June’s EU elections after German politician Markus Pieper resigned the night before his first day in office. Pieper, a controversial pick for the role, with von der Leyen being accused of favouritism for appointing him, resigned on Monday (15 April) just hours before he was supposed to formally start in the new role. Read more.

EU justice chief Reynders defends EU supply chain law against German liberals’ rebuke. EU Justice Commissioner Didier Reynders joined German Social Democrat ministers Hubertus Heil and Svenja Schulze to defend the EU supply chain legislation against ongoing criticism from Germany’s Free Democratic Party (FDP). The law “will not introduce any new reporting obligations,” he said at a closed-door session of an industry conference last week. Read more.

EU leaders lack Draghi and Letta’s ‘fire of urgency’, says Greens chief. European leaders lack the “fire of urgency” of Mario Draghi and Enrico Letta – authors of two strategic reports on the EU’s future – and are being driven by “political expediency”, the co-president of the Greens/EFA European Parliamentary group, Philippe Lamberts, warned on Thursday (18 April). Talking to the press on the sidelines of a European summit on competitiveness, Lamberts said EU leaders seem to be focusing on policies that threaten to lead the bloc towards “political suicide.” Read more.

A ‘difficult’ summit: Corporate tax, single supervision scrapped from conclusions. European Council President Charles Michel said the EU leaders’ competitiveness summit was tough, but significant decisions were still taken, as calls for harmonising corporate tax rules and centralising the supervision of financial sector firms were scrapped from the Council’s final conclusions. Read more.

[Edited by Zoran Radosavljevic/]

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A 'difficult' summit: Corporate tax, single supervision scrapped from conclusions

European Council president Charles Michel described EU leaders' competitiveness summit as “difficult” - as calls for harmonising corporate tax rules and centralising the supervision of financial sector firms were scrapped from the final Council conclusions.